"Macroeconomic Policies and Social Equity"

Speech by Rodrigo de Rato, Managing Director of the International Monetary Fund at the Opening Session of the ECLAC-IMF Conference
Lima, Peru
September 20, 2007

As Prepared for Delivery

1. Thank you very much. Let me begin by thanking the staff of the Fund and ECLAC who have done superb work in organizing this conference. I would also like to thank our hosts, the Government of Peru, and especially President Garcia, and our distinguished guests for giving us your time. It is a special pleasure to have with us so many parliamentarians who can help consolidate economic reforms into enduring changes in laws and institutions.

2. Let me begin by putting the focus of this conference—equity in macroeconomic development—in some context.

3. Over the last five years, Latin America has done extraordinarily well in terms of growth and of improvements in macroeconomic stability. The region has benefited from favorable external conditions—especially high prices for the commodities that many Latin American countries export. But it has also benefited from good economic management by governments and central banks. I talked last night about how this has offered the region some protection against the recent financial market turbulence. Sound economic policies have also led to the highest growth and the lowest inflation in nearly four decades.

4. These are enormously important achievements. Economic growth is fundamental not only for improving the average incomes of citizens, but also for the prospects of the poorest citizens. If the most active citizens of a country do not have hope that their standard of living will rise, they will devote their energies to moving out instead of moving up, to the detriment of the whole society. And inflation has for many years been an insidious tax on the poor, who are least able to protect themselves from its effects. There is now a strong political consensus that high growth and low inflation are fundamental components of equitable development, and that policy makers need to make sure that these gains are preserved.

5. But there is also a powerful case for tackling inequality and poverty directly through more effective social policies. This is a matter of social justice, and it is a matter of good sense. The human costs of poverty are profound, and there is increasing evidence that the economic costs are great, too. The urgency of addressing poverty and inequality in Latin America is also increased when we see evidence from other regions that globalization can make inequality within countries worse, because of the higher skill premium associated with technological advance and because of the unequal distribution of benefits from global trade.

6. Fortunately, there is much that policy makers can do to reduce inequality and poverty, while also supporting growth and stability. The agenda of this conference is centered around the policy areas where the greatest contribution can be made: fiscal policy, financial sector reform, and institutional reform. Let me say a few words about each.

7. The Greek scientist Archimedes said of the lever, "give me a firm place to stand, and I will move the earth." Handled well, fiscal policy can be the lever that supports growth and reduces inequality. Many countries are already taking initiatives that will help. For example, on the revenue side, a number of countries have recently introduced taxes that will be paid mostly by those with the greatest capacity to pay—especially taxes on vehicles, other property, and financial income. Governments could also reduce exemptions which normally benefit high earners and relatively wealthy consumers. Simpler taxes and broader tax bases will make it possible to set lower rates. Expenditure policy can also be used to promote equity and increase equality of opportunity. The most effective way to do this would be to pursue direct social policies that reallocate spending toward programs designed for the poor and away from the subsidies that heavily benefit middle- and upper-income groups. For example, subsidies for petroleum products and electricity could be replaced with direct social assistance. The quality of expenditure between sectors can also be improved. For example, we know that education is crucial for equality of opportunity, particularly in a globalized world. But a recent Fund study estimated that over half the benefits of spending on tertiary education go to the richest quintile of the population, while the poorest quintile get just 2 percent of the benefits. Equity could be improved if cost recovery was increased at the tertiary level, and if the proceeds were then used to strengthen the quality of primary and secondary education, where spending is of much more benefit to poorer people.

8. In the pursuit of equity, governments should also not neglect investment, which is essential for growth. Capital spending has fallen as a proportion of total government spending in Latin American countries. This may be explained partly by privatizations. However, expected increases in private sector investment have mostly not materialized. This must lead one to ask whether the combination of tax laws and public expenditure policies in key sectors are sufficiently encouraging to investment. For example, in the energy sector, the region has rich natural resources, but developing these will require much more investment. It is therefore important to create an environment that offers a competitive return to public and private investors under stable market conditions, and provides for stability of contracts and well-defined dispute resolution processes. However, public investment must also be strengthened. The new fiscal parameters require improved efficiency in the programming of public investment.

9. The second topic of discussion today is financial sector reform. There is a long agenda here, including reducing the costs of financial intermediation for all and protecting consumers through greater transparency in credit terms, including modernized bankruptcy laws to create a better environment for lending. But it is also important to broaden access to credit and financial services, which many of the poor in this region do not have. For example, small and medium enterprises—which are often the drivers of innovation and productivity growth—need access to finance to grow themselves. Steps can also be taken to encourage microfinance institutions. Peru has been one of the leaders in this field, with average growth in this type of credit of about 25 percent annually in recent years. Microfinance institutions can play a central role in providing credit to businesses in low-income areas and help people lift themselves out of poverty. They can also help to channel remittances toward productive investment and greater credit for households.

10. The third working session focuses on strengthening institutions. We should recognize that much progress has already been made on this: the consensus on the importance of sound macroeconomic policies has contributed to a strengthening of central banks and fiscal institutions, better financial supervision and a tougher stance on corruption. But we also need to build a consensus around strengthening other key institutions for employment, investment and poverty reduction, and around policies that promote growth in sectors that will generate the greatest improvements in income for the majority of citizens. I hope that today's discussion will focus on issues like simplifying procedures for setting up new businesses, which is a prerequisite for boosting employment; on measures to liberalize employment law, which could bring more workers into the formal sector and so promote equality and help to reduce poverty; and on the effective management of social programs, which directly affect the poor.

11. This will probably be my last visit to Latin America as Managing Director of the Fund. It does not seem very long ago that I visited Peru as a candidate for this position, here in Lima in March 2004, and received the generous support of Latin American governments. But in the time since then I have seen much progress and many positive developments in Latin America. I believe that historians will look back on the past decade as one in which Latin America addressed longstanding problems of instability and slow growth. I hope that they will see the next decade as one in which Latin America addressed issues of equity and overcame problems of poverty. And I hope that the discussion at this conference will be useful in setting us on the right road.

12. The IMF has given support to Latin American governments and societies during very difficult times of economic crisis and instability. At times, the Fund has been their only supporter. We therefore appreciate how challenging certain kinds of decisions can be. In this new era of greater opportunity, we must therefore do our part in such areas as macroeconomic surveillance, institution-building, and crisis prevention, in an effort to integrate Latin America more fully into the global economy, which is a prerequisite for achieving more rapid and sustainable growth as well as poverty reduction.